Foot-dragging on Wall Street

Washington must guard against a creeping complacency

Forgetting is supposedly a great healer – but not when applied to financial markets. It has been almost six years since the Lehman Brothers meltdown and four years since the Dodd-Frank reform was passed. The world came perilously close to a second Great Depression. To judge by the lack of urgency in Washington, those days are fading from memory. Barely half the rules required under Dodd-Frank have been written. And many of those that have been promulgated have diluted the law’s intent. Furthermore, Congress has yet to pass a bill to wind down Fannie Mae and Freddie Mac, the giant mortgage underwriters that were at the heart of the subprime crisis. The chances of that happening soon are also fading. Complacency is displacing fear. It is vital that Washington tackles the unfinished business of 2008 before it takes root altogether.

The largest outstanding item must be to wind down government-sponsored enterprises. Fannie and Freddie’s near bankruptcy just a few weeks before Lehman’s collapse prompted a $187.5bn taxpayer bailout. This was essential to preserve liquidity in the US mortgage market at a moment of acute stress. But it has long since passed. The US housing recovery is in its fifth year and household leverage ratios are almost back to pre-crisis levels. The temptation will be to leave the GSEs in federal “conservatorship”, since they are paying a handsome flow of dividends to the US Treasury. Congress must find the spine to wind them down.

Democratic lawmakers want to preserve homeowner assistance for the poor. That is a questionable goal that should take second place to creating a robust and affordable rental market for low-income Americans. In any event, it should be delivered by a pure public entity with transparent subsidies rather than via two privately held but implicitly guaranteed behemoths. Meanwhile, lawmakers in both parties are susceptible to hedge fund investors who own grey-market shares in the GSEs and want their cut of the renewed dividend flows. Again, the argument holds little water. Shareholders ought to have been wiped out when the US Treasury took over the GSEs. And the hedge fund lawsuit is irrelevant to the debate on Capitol Hill. The sooner Congress winds down the GSEs the better.div>

Progress on Dodd-Frank is also patchy. The fact that Congress was unable to consolidate Washington’s Balkanised regulatory set-up has made it easy for Balkanised regulatory set-up has made it easy for banks to lobby against the law’s toughest elements. They continue to shop around for the lightest-touch regulator. As Tim Geithner, former US Treasury secretary, explains in his memoirs, the so-called Volcker rule was integral to Dodd-Frank. It requires too-big-to-fail banks to hive off proprietary trading from their publicly insured subsidiaries. Yet banks have succeeded in eviscerating much of its contents. Other key rules, including one that would strengthen the ability of shareholders to undo reckless compensation practices, have yet to be written. If the big banks have their way, they never will. The same applies to rules on “dark pools” created by high-frequency trading, margin and capital requirements for money market funds, and addressing the conflicts of interest among rating agencies. These rules are long past due.

BARRY EICHENGREEN

MAY 12, 2014

BERKELEY – This month marks the fourth anniversary of the May 2010 financial rescue of Greece. Previously, the idea that a eurozone member would seek emergency assistance from the International Monetary Fund, along with the European Commission and the European Central Bank, was unthinkable. The rescue thus marked Europe’s descent into full-blown crisis.

Four years later, European officials are assuring everyone that the crisis is over. The IMF has raised its forecast for eurozone growth this year to 1.2%. Even Greece is forecast to grow by a modest but not insignificant 0.6%.

Bond markets, too, are indicating that the crisis is over. Yields on Irish government bonds have fallen below 3%. Last month, Portugal was able to issue ten-year bonds at 3.57%. Even Greece has been able to sell five-year bonds at rates below 5%.

Clearly, the supposed experts who predicted the imminent disintegration of the eurozone have been proved wrong. But it is equally likely that those now declaring that the crisis is over will be proved wrong as well.

If we have learned one thing from the last four years, it is that the European Union lacks the capacity to act decisively. With 28 member countries, decision-making processes are tedious and time-consuming. Common interests are difficult to define, making burden-sharing agreements difficult to reach. Action is regarded as more urgent in some quarters than in others.

Moreover, the patient is far from cured. Ireland, Portugal, Spain, and Greece have made considerable progress in lowering their unit labor costs to 1999 levels relative to Germany. The problem is that 1999 levels are not enough, because producers now have China and other emerging markets with which to contend. Italy and France, meanwhile, have made considerably less progress on improving their international competitiveness.

Nor is it clear where the crisis countries will find the demand that they need. With domestic spending subdued, they have been relying on exports. But now that growth in emerging markets has slowed, their export markets are weakening. Spanish exports, on a positive trend until recently, have stopped rising. And Spain may be the proverbial canary in a coalmine.

The ECB, for its part, continues to do too little to support demand. It has been behind the curve since 2011. If it finally turns to quantitative easing in June, it will take only baby steps down this path, because ECB President Mario Draghi and his team remain reluctant to embrace the kind of radical measures that would shock their political masters.

On the budgetary front, the new French and Italian prime ministers, Manuel Valls and Matteo Renzi, respectively, have proposed cutting taxes for low-paid workers and their employers. This is a positive step toward addressing the plight of those who have suffered the most from the unemployment crisis. But Valls and Renzi also plan to cut spending to prevent their budget deficits from rising, which means that their initiatives will not boost demand.

Meanwhile, Europe’s banking crisis is unresolved. Loans to finance fixed investment continue to fall. Remarkably, the European Banking Authority’s latest stress test for the eurozone’s banks does not contemplate the possibility of deflation in its adverse scenario. The implication is clear: The banks’ capital shortfall will be understated, and the amount of new capital they will be required to raise will be inadequate. If the goal is to restore confidence and get the banking system firing on all cylinders, this is not how to go about it.

And everyone knows that Europe’s much vaunted banking union is deeply flawed. It creates a single supervisor, but only for the largest banks. It harmonizes deposit-insurance coverage but does not provide a common deposit-insurance fund. The resolution mechanism for bad banks is incomprehensible and unworkable. The associated resolution fund will possess only €55 billion ($76.6 billion) of its own capital, whereas European bank liabilities are on the order of €1 trillion.

Finally, there is that pesky matter of public debt, which is still 90% of eurozone GDP. European officials propose to work this down to their target of 60% over a couple of decades. You read that right. Check back to see how they’ve done in 2034.

All of this has the makings of a dismal prognosis. But it is how Europe progresses. Its banking union may be flawed, but at least it exists, and over time those flaws can be fixed. The stress tests may be flawed, but at least they are better than Europe’s two previous attempts. ECB action this summer may underwhelm, but at least the eurozone’s monetary-policy officials will do something.

The eurozone will not collapse this year, but its troubles are far from over. Europe will not draw a line under its crisis. Decisiveness is not the EU way.

Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His most recent book is Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.

While the EU currently shows a united front on possible economic penalties against Russia for its interference in Ukraine, that could change once more serious sanctions are on the table. Germany is struggling to maintain the facade.

European Union politicians don't like to be outdone when it comes to showing resolve. Last week, French Foreign Minister Laurent Fabius said that if the Russians continue acting like they have, then tough new sanctions will need to be imposed. His British colleague William Hague said that economic sanctions were being planned. German Chancellor Angela Merkel threatened last Thursday that if there were problems surrounding the Ukrainian elections, "there would be further sanctions."

These strong words are the West's answer to Moscow's expansionist push. More than any other measure, it's the possible so-called third level of sanctions -- wide-ranging economic sanctions -- that are intended to make Putin back down. Because Europeans have ruled out the use of military means, these sanctions are the most powerful weapon that they have -- the diplomatic nuclear option in the battle over Ukraine's future.

But there's one problem with this weapon: It can only be used if all EU members agree. In the EU, sanctions need to be decided unanimously. This worked for levels one and two, because they were primarily symbolic acts that affected people close to Putin and imposed no real burden on the EU. But level three would be different, making it unlikely that the EU would agree on sanctions that would have a strong effect Russia. Europe's strongest weapon is actually a bluff.

Hawks vs. Doves

In her talk with Sigmar Gabriel, vice chancellor and head of the center-left Social Democrats, last Tuesday, Merkel reported that during consultations about sanctions many EU partners are most interested in talking about how to secure exceptions for their own economies. Others are trying to avoid the subject entirely.

But there's a lot to discuss. On one side, there are the states taking a hardline position -- this includes most Eastern European countries and Great Britain -- who would rather implement sharp sanctions now instead of later. On the other side there are the more cautious countries, like the Benelux states, which are betting on diplomacy, or, like all of Southern Europe, are afraid of the economic costs a trade boycott could bring.

The French and the Germans are taking a middle position: They don't want sanctions, but will support them if Putin continues to destabilize Ukraine. Germany, in particular, is betting on financial sanctions, which would mean using the European Investment Bank (EIB) and the European Bank for Reconstruction and Development to exert pressure on Moscow. At the EIB there's a list of projects that would be put on ice if sanctions were expanded.

Countries like Great Britain or Cyprus are strictly against this, because it would also have an effect on their own financial sectors, and are arguing, instead, for an energy boycott. However, this faces strong resistance from Eastern European countries, like Bulgaria or Slovakia, who depend almost entirely on Russia for gas.

Genuine economic sanctions would clearly be expensive for the Europeans. According to a confidential report by the European Commission, Germany would have to reckon with a loss of 0.9 percent in growth this year, and 0.3 percent next year. The situation looks even direr in other countries.

Sanctions May Not Work Anyways

Many governments are also skeptical that the sanctions could actually get Putin to back down. In German security policy circles, that outcome is considered almost impossible. The thumbscrews the West has thus far implemented "haven't instilled much fear" in Putin and his associates, one security official argued. Russia has little foreign debt and large currency reserves, giving it a transitional period of at least two years -- enough time to find new buyers and distribution routes for Russian gas. "We'll be sitting in the cold before the Russians run out of money," says one security official.

Putin's determination to secure his influence over eastern Ukraine is also related to the region's importance to the Russian armaments industry. The Russian army's airplane motors, gear boxes and rocket equipment are, according to Western knowledge, in large part built in eastern Ukraine. That's why the Kremlin has also, according to the security official, planned painful economic sanctions of its own. "If the Russian leadership sees itself as strong, even if we don't see it that way, then it will also act strong -- and at the moment it feels very strong."

Although the 28 EU member states try hard to project a sense of unity to the outside world, their differences in opinion make themselves felt in internal meetings. Merkel is afraid that, in the end, the Union's disunity could spill into the open and Putin would have accomplished one of his important goals, dividing the Europeans.

Looking for Ways to Avoid the Issue

That's another reason why the German government wants to avoid, at all cost, a situation in which sanctions are unavoidable. Foreign Minister Frank-Walter Steinmeier has pointed out that Moscow has recently stopped questioning the legitimacy of the Ukrainian presidential elections, which are planned for May 25. The German government is grasping for these kinds of signals, because they may serve as a reason not to implement the third level of sanctions.

Before concrete steps can be defined, the EU also needs to discuss when the third level should even be implemented -- a way to skirt the delicate situation. "Clearly there will be economic sanctions if Putin sabotages the vote," says a high-ranking government official. "But it's unclear what would constitute sabotage."

One way to at least defer the debate around sanctions would be to push the Ukrainians to delay the vote. But the German government does not want that at all, because it would seem like a capitulation to Putin. "A delay isn't in our script," Markus Ederer, a state secretary in Steinmeier's Foreign Ministry, stated last Wednesday during a session of the German parliament's foreign affairs committee.

Brain science fires up the neurons of managers

Every day David Amodio comes face to face with prejudice − not in the form of insults and put-downs – but as hotspots and squiggles on PC screens depicting the brain behaviour of people shown pictures of strangers from other racial groups.

Professor Amodio, who teaches at New York University, is a pioneer of social neuroscience, an interdisciplinary field that explores the neural reactions underlying phenomena such as motivation, prejudice and co-operation. “The science tells us what humans can do and also what their limitations are,” he says.

Some management experts believe such scientific exploration of the brain is helpful to businesses. Last month the UK’s Chartered Institute of Personnel and Development hosted seminars on what neuroscience has to teach leaders and trainers. Meanwhile employers from banks to IT companies have been calling in academics and coaches to talk about its implications for the world of work.

By probing the neural roots of behaviour that psychologists have puzzled over, neuroscience may help to solve conundrums such as why many companies still struggle to create socially and ethnically diverse workplaces even though they profess equal opportunity.

At Prof Amodio’s NYU, volunteers wearing scalp sensors took part in experiments assessing their susceptibility to stereotyping others. Those who turned out to be fairly unprejudiced showed greater electrical activity in brain regions associated with self-control, suggesting they were working hard to stay focused on the task and respond impartially.

This suggests that the brain can apply a conscious override to knee-jerk bias. Other experiments measuring threat responses in the brain agree with the idea that while we may instinctively mistrust “difference”, the brain’s neocortex – which evolved as primate social networks became more complex – has mechanisms to keep prejudice at bay. “Though we may have unconscious prejudices, we can be adept at regulating our behaviour,” says Prof Amodio.

Such research could provide pointers for employers. For example, if prejudice is partly innate, encouraging managers to spot their prejudices and work around them may be more effective than repeating the mantra that prejudice is wrong.

Such an approach might have helped Zillah Byng-Maddick, chief financial officer at Future Publishing. At a past employer, she confronted a personal prejudice in the shape of a well-qualified but obese interviewee. Try as she might, she could not silence the thought that overweight people are lazy. “I kept saying to myself, listen to what they have to say . . . .but I couldn’t get past their weight.”

Her response was probably doomed to fail. “Trying to suppress a bias usually backfires, because it keeps you thinking about the bias all the more,” says Prof Amodio. However, her current approach − to talk first by phone, so that her first impressions are unaffected by looks − he says, is spot on.

At the University of California, Los Angeles, Matthew Lieberman has been exploring the part of the brain that deals with social relationships through “functional magnetic resonance imaging”. In his book, Social, Why Our Brains Are Wired to Connect, Prof Lieberman writes that brains feel a social form of hurt – such as exclusion and unfairness – much as they experience the physical pain of, say, breaking a leg.

Yet most organisations, he writes, miss this vulnerability. Employers appoint task-focused managers who lack human understanding, and trust that money will motivate employees, overlooking social rewards such as praise and opportunities to help others flourish which, he argues, the brain registers just as powerfully.

When it comes to holding an audience, neuroscientists have an advantage over many presenters – a picture of neurons firing is more compelling than talking theory and data points.

Tips for avoiding ‘neuro-bunk’

●Do not be overly impressed by pictures of brains lighting up – a popular sales device, according to Tara Swart, a neuroscientist and leadership coach. Dig into the detail and beware of generalisations.

● Be aware that neuro-imaging techniques are still broad-brush in spite of big advances, advises Molly Crockett, a neuroscientist at University College London.

● Ask if findings have been peer-reviewed and replicated and be cautious about small experiment samples.

● Consider Dr Crockett’s rule of thumb: “The more wonderful a thing sounds, and the more you’d like to believe it, the less likely it is to be true.”

Steven Rice, who leads human resources at IT company Juniper Networks, was won over by the explanatory power of neuroscience. He had already sensed that many Juniper employees regarded the ranking system used to evaluate them as unfair. But it was reading about how the brain reacts to threat and unfairness, in Your Brain at Work, by the consultant David Rock, co-founder of the NeuroLeadership Institute, he says, that motivated him to redesign Juniper’s performance management process from scratch. “It was one of those ‘Aha!’ moments, when two things came together.”

Faith that neuroimaging can supply management insights is not universal. First, say sceptics, most brain regions perform multiple functions, making the interpretation of brain activity difficult.

“I don’t think there’s any area we can say is [such and such] an area, and be really confident that’s a correct statement,” says Russ Poldrack, a psychology and neurobiology professor at the University of Texas.

There are also limits to what neuro­imaging can observe, while preliminary findings from small-scale studies are often regurgitated as facts. Managers need to be aware that there is neuro-myth alongside the neuroscience.

“Anyone can call themselves a coach and many people quote neuroscience with no right,” says Michael Brooke, UK head of learning and development at BNP Paribas, the French bank. To talk about unconscious bias and the psychology of trading, he hired a coach with a neuro­science PhD who had also trained as a doctor. Her credentials, he says, reassured him.

Molly Crockett, a neuroscientist at University College London, has a rule of thumb for spotting “neuro-bunk”: “The more wonderful a thing sounds, and the more you’d like to believe it, the less likely it is to be true.”

Likewise, people are often readier to believe that commercial “brain-training” programmes will make them smarter, than act on evidence that exercise improves learning and cognition – possibly because exercise is hard work.
“While we have quite clear evidence of the effects of exercise, very few brain-training programmes on the market have been scientifically validated,” says Paul Howard-Jones, a reader in neuroscience and education at the University of Bristol.

Prof Lieberman conjectures that, in coming decades, neuro­imaging will progress from stationary scanners to wearable headbands affordable to businesses and even schools.

This raises the possibility – or the spectre, depending on your perspective – of employers adding brain-response diagnostics to the panoply of psychometrics already deployed in leadership selection and development.

For now, however, the focus is on teaching executives brain awareness rather than probing into their brains. Ms Byng-Maddick has a personal story. Raised on the adage: “show me the boy at seven and I’ll show you the man”, she believed individuals either have what it takes or do not.

However, learning about neuro­plasticity – the idea that the adult brain reorganises itself and forges new connections − persuaded her that people can develop.

Faced with the dilemma of how to handle an unhappy deputy whom she had beaten to a coveted post, she decided to mentor him. When she got promoted, he got her job. “Had I not learnt about the brain, I’d have handled the situation differently,” she says.

You can call it a bailout, a rakeover – I mean, takeover – or socialism for cash. It’s all that and more.

But, whatever you call it, it’s not going to last.

The $187.5 billion bailout of Fannie Mae and Freddie Mac back in 2008 was absolutely necessary.

Before you tell me I’m crazy, let me tell you why…

There are no ifs, ands, or buts about it. Forget that Fannie and Freddie caused their own demise – that’s another discussion. Once they imploded, they had to be saved for the sake of every American bank, more than a few giant global banks, the U.S. economy, and probably the global economy.

To live and die another day, Fannie and Freddie had to issue senior preferred securities to the U.S. Treasury for bailing them out. The preferreds paid a 10% to the Treasury.

(Remember that Fannie and Freddie don’t make mortgages. They buy mortgages from lenders, package them to sell to investors, and guarantee the securities they issue. This all makes them a pretty good investment, so they buy their own stuff by the fistful.)

Of course, there was a problem. Neither could make the payments. So, our government being the generous sort it is, lent F&F money to pay the government. How’s that for good business sense?

Well, wouldn’t you know it, by 2012, this pair of government-sponsored enterprises were again enterprising and making tons of money.

That’s when the Obama administration, never one to miss an opportunity to extract or extort cold hard cash from any wounded-warrior veterans of the economic drain game, changed the rules for being paid back. In August 2012, the Treasury made the dynamic duopolies deliver all their profits to the saviors who bailed them out.

There would be no more piddling 10% dividends – Uncle Sam wanted all their profits. And he got them. To date, Fannie and Freddie have paid the Treasury more than $200 billion. By June, that amount will have risen to an estimated $213 billion.

What’s bad is that last Thursday, just as the dumb-ass duo was forking over another $10.2 billion to the Treasury, the Senate Banking Committee, on the same day, lost control of its opportunity to revamp the whole stupid arrangement that gave life to the world’s biggest government-sponsored enterprises (aka GSEs). Come to think of it, there are pretty much no other GSEs. Well, there are, but they’re “state owned” entities, some of which are sponsored by communists and socialists. As they say, if the shoe fits … wear it.

But I digress.

And who stopped the reform efforts in the Senate? A few good Democrats, that’s who.

You can’t blame them. Honest extortion tactics are hard to come by these days.

Don’t get me wrong, I don’t give a hoot that F&F have to pay back everything they make to the government. I care that this stupid government of ours spends – make that wastes – this money like a drunken sailor.

But that’s another discussion.

What’s really galling is that these two Frankenstein monsters weren’t broken up when they should have and could have been.

Fannie and Freddie’s moneymaking ways are about to end. The extortion game is going to turn into another black hole when they stop extorting money themselves. The two are making so much money because they’re suing big banks for billions upon billions of losses they incurred on the crappy mortgages they bought from the banks. F&F then packaged this junk into crappy mortgage-backed pools that they themselves bought, which is really what sunk them.

When it comes to making the same mistakes again and again, it’s not a question of “if,” but “when.”

The government has to get out of the mortgage business. They got into it during the Great Depression, and it made sense then, for a while. But that’s a long, long time ago.

F&F have spent hundreds of millions of dollars paying lobbyists to make sure Congress doesn’t take away their GSE stinking badges. They can’t pay out money directly anymore. But that doesn’t mean they won’t be able to down the road when this past little kerfuffle is all forgotten about.

It’s extortion all around. And who’s the biggest victim of this rakeover? The taxpayers, as usual.

For heaven’s sake, the F&F Express to Hell has to be derailed before it steam-rolls the economy again.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.